International Studies Program Working Paper 99-3 July 1999 Fiscal Decentralization in the Russian Federation during the Transition Jorge Martinez-Vazquez L.F. Jameson Boex Fiscal Decentralization in the Russian Federation during the Transition Jorge Martinez-Vazquez and Jameson Boex * Department of Economics School of Policy Studies Georgia State University December 1998 (Revised July 1999) * We would like to thank Roy Bahl, Michael Bell, Richard Bird, Lev Freinkman, Albert Igudin, Galina Kourliandskaia, John Mikesell, Yelena Nikolayenko and Sally Wallace for their comments and many helpful suggestions. We are grateful to Lev Freinkman, Stepan Titov and Alexander Morozov for sharing various data sets with us. This research was funded by the U.S. Agency for International Development under Georgia State University’s Russian Fiscal Reform Project and the World Bank Institute. The opinions expressed in this study are strictly the authors’ own, and should not be attributed to either USAID or the World Bank. FISCAL DECENTRALIZATION IN THE RUSSIAN FEDERATION DURING THE TRANSITION Jorge Martinez-Vazquez and Jameson Boex TABLE OF CONTENTS LIST OF TABLES ........................................................ -iii- CHAPTER I THE DYNAMICS OF DECENTRALIZATION IN THE RUSSIAN FEDERATION -1- I.1 The Forces behind Decentralization in the Russian Federation ............. -2- I.2 A Historical Overview of Intergovernmental Fiscal Relations Since 1992 .... -6- I.3 The Role of Politics in the Decentralization Process ................... -10- I.4 Dimensions of Fiscal Decentralization in the Russian Federation .......... -13- CHAPTER II EXPENDITURE RESPONSIBILITIES ................................. -15- II.1 How Have Expenditures Been Assigned? ........................... -15- II.2 How Has the System Performed ? ................................. -22- II.3 Pending Policy Issues in Expenditure Assignments .................... -26- CHAPTER III REVENUE ASSIGNMENTS AND TAX ADMINISTRATION ISSUES ........ -35- III.1 How Have Revenues Been Assigned? .............................. -35- III.2 Trends in Revenue Collections ................................... -41- III.3 How Has the System Performed? ................................. -44- III.4 The Role of Perverse Incentives and Soft Budget Constraints ............ -49- III.5 The Role of Tax Administration .................................. -50- III.6 Pending Reform Agenda in Revenue Assignments ..................... -52- CHAPTER IV THE SYSTEM OF TRANSFERS ............................................ -58- IV.1 Evolution of the System of Transfers .............................. -58- IV.2 The Current System of Transfers ................................. -62- IV.3 How Has the Transfer System Performed? .......................... -66- IV.4 Pending Policy Agenda for the Reform of Transfers ................... -70- -i- CHAPTER V SUBNATIONAL BORROWING, DEBT AND FINANCIAL CONTROLS ...... -76- V.1 Evolution of the Legal Framework for Borrowing .................... -76- V.2 Analysis of Subnational Deficits and Debts .......................... -77- V.3 Pending Policy Agenda for the Reform of Subnational Borrowing ........ -82- CHAPTER VI IMPLEMENTING REFORM ......................................... -86- VI.1 Piece-meal versus Unified Reform Strategy .......................... -86- VI.2 Uniform versus Asymmetric Federalism and Addressing Fiscal Disparities .. -87- VI.3 Compliance with the Federal Laws by the Regions .................... -89- VI.4 Communications Between Federal and Regional Governments ........... -91- VI.5 Determining the Form of Fiscal Federalism .......................... -91- REFERENCES .......................................................... -94- -ii- LIST OF TABLES Table 1: Assignment of Expenditure Responsibilities in the Russian Federation in 1997 .... -98- Table 2: Distribution of Expenditures Between the Levels of the Government, 1992-1997 . -99- Table 3: Distribution of Expenditures Between the Levels of the Government, 1992-1997 -100- Table 4: Distribution of Expenditures by Function Between the Levels of Government, 1992-1997 ..................................... -101- Table 5: Average Regional Expenditures by Category, as Percent of Total Regional Expenditures, 1994-1997 ..................................... -102- Table 6: Evaluation of Composition of Expenditures for Subnational Governments in Real Terms, 1992-1997 ........................................... -103- Table 7: Regional Economic Disparities in the Russian Federation: Per Capita Gross Regional Product , Selected Years from 1992-1996 ........................ -104- Table 8: Measures of Horizontal Fiscal Imbalance in the Russian Federation: Per Capita Consolidated Regional Expenditures, 1992-1997 .......................... -105- Table 9: Level of Equalization at Different Stages of Revenue Assignment: Coefficient of Variation of Cumulative Per Capita Allocation, 1992-1997 ........ -106- Table 10: Regional Socio-Economic and Demographic Variables: Descriptive Statistics .. -107- Table 11: Determinants of Per Capita Expenditures, 1994-1997 ..................... -108- Table 12: Determinants of Per Capita Expenditures on National Economy, 1994-1997 ... -109- Table 13: Determinants of Per Capita Expenditures on Housing and Public Utilities, 1994-1997 ................................................ -110- Table 14: Determinants of Per Capita Expenditures on Education, 1994-1997 .......... -111- Table 15: Determinants of Per Capita Expenditures on Public Health and Physical Education, 1994-1997 ....................................... -112- -iii- Table 16: Expenditure Assignment in the Budget Code, 1998 ...................... -113- Table 17: Legislated Sharing Rates of Major Taxes in the Russian Federation .......... -114- Table 18: Status of Taxes in the Tax Code (1998) ............................... -115- Table 19: Own Revenues and Shared Revenues as a Percentage of Consolidated Subnational Collections (Excluding Transfers and Subventions) .... -116- Table 20: Distribution of Revenues Between the Levels of Government, 1992-1997 ..... -117- Table 21: Russia: Consolidated Subnational Own Source Revenue Collections, 1997 ..... -119- Table 22: Summary of Legislative Control over Subnational Own Source Revenues ..... -120- Table 23: Distribution of Revenues Between the Levels of the Government, 1992-1997 .. -121- Table 24: Evaluation of Composition of Revenues for Subnational Governments in Real Terms, 1992-1997 ........................................... -122- Table 25: Russia: Measures of Vertical Fiscal Imbalance for the Subnational Sector, 1997 . -123- Table 26: Measures of Vertical Fiscal Imbalance for the Subnational Sector: An International Comparison ......................................... -124- Table 27: Measures of Regional Fiscal Disparities in the Russian Federation: Per Capita Revenue Collections (including Federal Share), 1993-1997 .......... -125- Table 28: Concentration of Total Revenue Collections (Including Federal Share) Among Regions: Share of Total Revenues Collected by Selected Regions, 1993-1997 .... -126- Table 29: Concentration of Regional Revenue Collections Among Regions: Share of Regional Revenues Collected by Selected Regions, 1992-1997 ......... -127- Table 30: Analysis of Regional Natural Resource Tax (NRT) Collections, 1994-1997 .... -128- Table 31: Fund for Financial Support of the Regions (FFSR) ...................... -129- Table 32: Formula for Allocating FFSR Transfers, 1999 .......................... -131- -iv- Table 33: Funding Sources for the Regions of the Russian Federation: Average Regional Funding by Source as Percent of Total Expenditures, 1992-1997 -132- Table 34: Federal Transfers to the Regions, 1992-1997 ........................... -133- Table 35: Evaluation of Composition of Transfers for Subnational Governments in Real Terms, 1992-1997 ........................................... -134- Table 36: Regression Analysis: Per Capita FFSR Transfers, 1994-1997 ............... -135- Table 37: Regression Analysis: Per Capita Other Transfers (Excluding Budget Loans), 1994-1997 ................................................. -136- Table 38: Regression Analysis: Allocation of (Per Capita) Regional Resources, 1994 ..... -137- Table 39: Regression Analysis: Allocation of (Per Capita) Regional Resources, 1995 ..... -138- Table 40: Regression Analysis: Allocation of (Per Capita) Regional Resources, 1996 ..... -139- Table 41: Regression Analysis: Allocation of (Per Capita) Regional Resources, 1997 ..... -140- Table 42: Explaining Tax Effort for Regional Collections, 1994-1997 ................ -141- Table 43: Explaining Tax Effort for Overall Collections (Including Federal Share), 1994-1997 ................................................. -142- Table 44: Percent of the Executed Share of a Region in the FFSR ................... -143- Table 45: Russia: Consolidated Budget Execution as Percent of GDP, 1992-1997 ....... -145- Table 46: Relative Size of Subnational Debt: Comparison of Selected Countries ........ -146- Table 47: Regression Analysis: Per Capita “Other Sources of Financing”, 1994-1997 .... -147- -v- CHAPTER I THE DYNAMICS OF DECENTRALIZATION IN THE RUSSIAN FEDERATION Intergovernmental fiscal relations may be the most contentious issue in the Russian Federation today. This is the result of the complexity of the problems intertwined with intergovernmental relations. These problems include the recent history of disintegration of the Soviet Union; the war in Chechnya; the ethno-linguistic, religious